Coronavirus: monetary policy is not enough
The US Federal Reserve’s emergency 50bp cut in interest rates on Tuesday failed to reassure markets. The US and European response to the Covid-19 coronavirus outbreak needs to incorporate targeted fiscal policy as well.
The main US stockmarket indices ended the day about 3% down on Tuesday. Investors are far from convinced that central banks can offset the economic disruption of coronavirus, and they are right.
Some have been warning that markets could fall much further when companies reveal first quarter earnings, starting in April.
The Organisation for Economic Co-operation and Development has cut its forecast for euro area growth this year from 1.1% to 0.8%. Italy is predicted to score a big fat zero. The US fares better, with the prediction just ticking down 10bp to 1.9%. But all these figures are based on the assumption that Covid-19 outbreaks outside China remain “mild and contained”.
The Fed and European Central Bank have been the backbone of global equity and bond markets over the last 10 years. Low rates have allowed companies to borrow cheaply and buy back shares. Monetary easing has pushed investors into stocks in search of returns.
But central banks' power over markets is now reaching its limits. Monetary levers cannot produce a vaccine for Covid-19, nor contain an outbreak.
It is true that they can mitigate the economic impact of the disease. And the ECB may need to follow the Fed with monetary stimulus, as a supply side shock threatens to sabotage demand. Vicky Redwood, senior economic adviser at Capital Economics, reckons that weak demand and a falling oil price will keep a lid on inflation.
However, government spending programmes are likely to be more effective than monetary easing, and should lead the response.
Before the coronavirus outbreak shook the market, investors and economists were anyway coming round to the idea that fiscal stimulus in the eurozone would boost growth and be accepted happily by bond markets in an era of low interest rates. And it goes without saying that demand for US Treasuries will not dry up any time soon, giving the US a free hand to spend.
Governments could use fiscal firepower to beef up health provision or help specific regions' economies. Central banks cannot target their bazookas in the same way. Meanwhile, rates in the eurozone are so low already it is hard to see how effective further cuts could be.
Central banks can do more than just lower rates, of course. Some have speculated that the use of the word “targeted” in an ECB statement on Monday suggested the institution might offer a new round of targeted longer-term refinancing operations (TLTRO).
Helping people and businesses struggling with cash flow or liquidity problems due to Covid-19 may be very beneficial. ECB policies like TLTRO could do that by giving banks an incentive to relax credit terms or offer forbearance to struggling debtors.
But it is not clear why this type of support has to come from central banks rather than from governments, which can, again, target policies more effectively at those who need them. Lawmakers are better placed to demand that, if this support does flow through the banking sector, those firms are forced to be tolerant of borrowers in arrears.
Governments taking action also makes the coronavirus response democratically accountable. The threat to central bank autonomy in recent years has emerged in part because those institutions have become so influential to the broader economy since the crisis.
It is time for politicians to open the spending taps, rather than continuing to pass the buck to central bankers.